Without the Fed and the Treasury, the shareholders of every single money-center bank and shadow bank in the United States would have gone bust.
Chart of the day, Morgan Stanley bailout edition: Ladies and Gentlemen, this is what a lender of last resort looks like…. The black line is Morgan Stanley’s market capitalization, which… fell as low as $9.8 billion in November 2008. The orange line is the amount that Morgan Stanley owed to the Federal Reserve… which peaked at $107 billion on September 29, 2008. And the red line is… Morgan Stanley’s debt… as a percentage of its market value. That ratio… peaked… north of 750%.
Many congratulations are due to Bloomberg, for extracting this information…. [I]f the ECB wants to avert a liquidity crisis, charts like this give a sobering indication of just how far it might have to go, and how quickly it might have to act…. The Fed didn’t blink: it kept on lending, as much as it could, to any bank which needed the money, because, in a crisis, that’s its job.
The Fed likes to say that it wasn’t taking much if any credit risk here: that all its lending was fully collateralized, etc etc. But it’s really hard to look at that red line and have a huge amount of confidence that the Fed was always certain to get its money back. Still, this is what lenders of last resort do….
The Fed’s argument against publishing the data was that it “would create a stigma”, and make it less likely that banks would tap similar facilities in future. But I can assure you that at the height of the crisis, the last thing on Morgan Stanley’s mind was the worry that its borrowings might be made public three years later…
In the fall of 2008, counting the Fed and the Treasury together, a peak of 90% of Morgan Stanley's equity--the capital of the firm genuinely at risk--was U.S. government money. That money was genuinely at risk: had Morgan Stanley's assets taken another dive in value and blown through the private-sector's minimal equity cushion, it would have been taxpayers whose money would have been used to pay off the firm's more senior liabilities. "Fully collateralized" the loans may have been, but had anything impaired that collateral there was no way on God's Green Earth Morgan Stanley--or any of the other banks--could have come up with the money to make the government whole.
When you contribute equity capital, and when things turn out well, you deserve an equity return. When you don't take equity--when you accept the risks but give the return to somebody else--you aren't acting as a good agent for your principals, the taxpayers.
Thus I do not understand why officials from the Fed and the Treasury keep telling me that the U.S. couldn't or shouldn't have profited immensely from its TARP and other loans to banks. Somebody owns that equity value right now. It's not the government. But when the chips were down it was the government that bore the risk. That's what a lender of last resort does.
That's why Bagehot's rule is to lend freely but at a penalty rate. The bankers should not profit from the fact that they were over leveraged, and compelled the government to act as a lender of last resort.